A Bonus-Malus Framework for Cyber Risk Insurance and Optimal Cybersecurity Provisioning

TL;DR

This paper introduces a Bonus-Malus framework for cyber risk insurance that incentivizes cybersecurity mitigation and addresses moral hazard, supported by a mathematical model and dynamic programming algorithm.

Contribution

It develops a novel Bonus-Malus model for cyber insurance, incorporating incentives for cybersecurity mitigation and providing an efficient numerical solution method.

Findings

Properly designed Bonus-Malus contracts can reduce moral hazard.

The model effectively incentivizes cybersecurity mitigation.

Numerical experiments show benefits for insurers and policyholders.

Abstract

The cyber risk insurance market is at a nascent stage of its development, even as the magnitude of cyber losses is significant and the rate of cyber loss events is increasing. Existing cyber risk insurance products as well as academic studies have been focusing on classifying cyber loss events and developing models of these events, but little attention has been paid to proposing insurance risk transfer strategies that incentivise mitigation of cyber loss through adjusting the premium of the risk transfer product. To address this important gap, we develop a Bonus-Malus model for cyber risk insurance. Specifically, we propose a mathematical model of cyber risk insurance and cybersecurity provisioning supported with an efficient numerical algorithm based on dynamic programming. Through a numerical experiment, we demonstrate how a properly designed cyber risk insurance contract with a Bonus-Malus system can resolve the issue of moral hazard and benefit the insurer.